India curbs FX outflows, targets gold imports in new rupee salvo

India curbs FX outflows, targets gold imports in new rupee salvo

MUMBAI (Reuters) - India imposed restrictions on foreign exchange outflows and gold imports on Wednesday in a new attempt to prop up the rupee, as a spike in inflation added pressure on policymakers to curb a crippling external deficit.

Finance Minister P. Chidambaram also reiterated his pledge to narrow the current account deficit - the main source of the rupee's weakness - to 3.8 percent of gross domestic product this fiscal year and said the currency would not be allowed to slide into "free fall".

The Reserve Bank of India's latest steps to support the currency, which has plumbed record lows against the dollar, included cutting the amount of overseas direct investments allowed by Indians. Those investments reached $3.2 billion in July, according to central bank data.

Separately, the central bank banned imports of gold coins and bars, which constituted about 36 percent of total billion demand in India last year, and will require domestic buyers to pay cash for the yellow metal, among other measures.

"This is obviously an extreme action, but these are extraordinary times and require extraordinary measures," said Sujan Hajra, chief economist of brokerage Anand Rathi in Mumbai.

The steps came as data showed the headline inflation rate jumped above the central bank's target range of 4 to 5 percent in July for the first time since March, making it even harder for the bank to refocus on supporting India's slowing economy.

The Indian authorities fear continued falls in the rupee will exacerbate the current account deficit in the short term, deter investment and further curb growth in Asia's third-largest economy.

Central bank action to tighten rupee liquidity in mid-July and other steps have failed to halt the slide in the currency, which set new record lows on August 6.

Chidambaram sought to address skepticism in financial markets since he first announced on Monday his target to cut the current account deficit to $70 billion, or 3.8 percent of GDP, from a record high 4.8 percent in the year ended in March.

Proposals announced on Tuesday to raise duties on gold and silver imports in a bid to curb demand have also failed to convince investors, who believe stronger measures are needed.

"I make a commitment on the current account deficit on behalf of the government. We will leave no stone unturned to contain the current account deficit at about $70 billion," Chidambaram told lawmakers on Wednesday.

"We cannot allow the rupee to go into a free fall."

The partially convertible rupee slipped to 61.45 per dollar on Wednesday.

It is down 2.5 percent since the RBI launched its major support effort on July 15, which included raising short-term interest rates.

However, the RBI on Wednesday also sought to ease some of the liquidity constraints at banks by exempting some requirements on the types of cash and government securities lenders must keep with the central bank.

Chidambaram also said that the central bank's mandate must include growth and employment, while Arvind Mayaram, economic affairs secretary, told reporters that any measures put in place would not be permanent.

"As and when we believe that the speculative pressure on the rupee is easing and the rupee is finding its stable environment, then the Reserve Bank of India and the government of India will revisit these restrictions and take an appropriate decision," Mayaram said.

Traders had previously criticized mixed signals from government and central bank officials, saying it raised doubt about their resolve and contributed to the rupee's weakness.

UGLY INFLATION

India's headline inflation rate, measured by the wholesale price index, accelerated to 5.79 percent annually in July from 4.86 percent in June, data showed on Wednesday.

With fears growing that India is headed into a phase of slowing growth and high inflation, 10-year bond yields surged to as high as 8.55 percent, their highest in more than a year.

Analysts said the bad news on inflation, particularly on prices for imported oil prices, was due in part to the rupee losing 12 percent against the dollar since the start of May and higher food prices.

"The July print for headline inflation is very ugly," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.

"Despite an acute slowdown in domestic demand, the manufacturing prices have remained elevated due to rising input costs on account of massive depreciation of rupee."

The need to bolster confidence has become more pressing. Foreign investors have sold a net $11.6 billion in debt and equities since late May, a bad omen given markets could weaken more when the U.S. Federal Reserve rolls back its monetary stimulus.